Consider the entrepreneur described in Section 14.1 (and referenced in Tables 14.114.3). Suppose she funds the project by borrowing $750 rather than $500.

a. According to MM Proposition I, what is the value of the equity? What are its cash flows if the economy is strong? What are its cash flows if the economy is weak?

b. What is the return of the equity in each case? What is its expected return?

c. What is the risk premium of equity in each case? What is the sensitivity of the levered equity return to systematic risk? How does its sensitivity compare to that of unlevered equity? How does its risk premium compare to that of unlevered equity?

d. What is the debt-equity ratio of the firm in this case?

e. What is the firms WACC in this case?

14.1

Date 0	Date 1
	Strong Economy	Weak Economy
-$800	$1400	$900

14.2

Date 0	Date 1 : Cash Flows		Date 1: Returns
Initial Value	Strong Economy	Weak Economy	Strong Economy	Weak Economy
Unlevered Equity $1,000	$1,400	$900	40%	-10%

14.3

	Date 0	Date 1: Cash Flows
	Initial Value	Strong Economy	Weak Economy
Debt	$500	$525	$525
Levered Equity	E = ?	$875	$375
Firm	$1,000	$1,400	$900